The Alternative Answer Daily

Finding Yield In Alternatives

This article originally appeared as part of Bob’s alternative investing column on Forbes.com.

The best known income “alternative” class is MLPs, master limited partnerships. There are many flavors, but the “midstream” variety is most popular; these own the infrastructure assets used to get and transport oil and gas, rather than the commodities themselves (which makes their returns steadier). And because they can grow their businesses over time but remain tax-free– a rare combo– their track record for increasing payouts over time is quite good. That dampens interest rate risk. Even better, the cash flow is tax-advantaged… if you invest in the right way, which, surprisingly, does not include mutual funds or ETFs. More on these next week.

Royalty trusts, which earn income directly from natural resource rights, often pay very high yields– but they can be volatile, and don’t forget to check the expiration date on the trust’s rights; the income flow doesn’t last forever. Meantime, several “multiclass” ETFs combine income streams from royalties and other non-tradtional sources into one easy-to-buy package.

Another standard issue “alternative”: Business development corporations (BDCs), which are essentially junior varsity private equity firms. Most of these lend to smaller companies, and pay out the interest they receive to investors… at generally attractive rates. But do be very careful about fees here, and avoid the non-traded variety… if you’re going to get into illiquid investments, there are better ways to do it (like, privately placed SBIC funds).

Let’s move on to something you may not know much about. My favorite new income play is “peer to peer” lending, which essentially dis-intermediates banks, and lets savers lend directly to pools of individual borrowers. The companies running these sites (the biggest is LendingClub) do some basic spadework on potential borrowers, checking their credit scores and employment status, and the borrowers explain in their applications why they want to borrow. Very often, it’s to pay down super high interest credit card debt– meaning the person is happy to offer you an 9% return to pay off an 18% loan, a win-win.

Of course, the issue is credit risk, but two points there. First, the sites allow you to spread your investment around, and over a large enough group of borrowers with the right credit scores, the default rate turns out to be pretty predictable (and is computed into your expected returns). Secondly, the good news is that you’re being paid quite well to take those risks. That’s very different from the interest rate risk inherent in most bonds these days… take another look at Buffet’s comments that kicked this column off.

These few examples should be enough to whet your appetite– there are indeed numerous alternative income sources out there that can juice up your current income and also diversify your risks. For more, check out www.altanswer.com, or… you guessed it, pick up The Alternative Answer.

Tomorrow, we’ll take a spin around some classic strategies for protecting yourself against the next big market downturn and show you exactly why portfolios with good alternative strategies outperform 60/40 portfolios over time.

Warren Buffett on bonds: instead of offering risk-free returns, they’re providing “return-free risk.” Bill Gross says the 30 year bull market in bonds is over. When those two are in violent agreement, it’s time to listen.

The situation is so dire that bond funds are piling into… stocks. (Morningstar MORN -0.25% reports over 300 bond funds have that little surprise for their investors.) And pension plans are resorting to junk bonds despite the risks and pathetic 5% yields. Yikes!

Fortunately, there are indeed attractive alternatives. We’ll mention a few here today, and then drill down on them, and many others, in future columns. (If you just can’t wait, feel free to grab my new Harper Collins book, The Alternative Answer). Choices include ETFs and several other traded securities; web-enabled direct lending; and specialty finance partnerships that invest in everything from foreign consumer receivables to equipment leases.

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